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Tuesday, June 2, 2009

Update on the Potential for Devaluation in Latvia

As I pointed out recently in the context of Latvia and the impending potential for a devaluation there is a distinct risk of falling victim to the sin of crying wolf. Yet, as the plot inevitable thickens I am maintaining, as it were, my cry. There are two significant points to think about in the context of what we might call recent developments. First of all there is the news that the 2009 deficit envisaged in the budget before the Latvian parliament will amount to 9.2% of GDP - significantly higher than the original IMF agreed "limit" of 5%, and even well above the latest negotiating objective of the Dombrovskis government of 7%. Of course, this is just number salad but at the end of the day it is important because it determines whether and under what condition the IMF funded bailout packaged continues. The fact that Latvia reports a deficit of this magnitude almost amounts to throwing in towel in my opinion or at least it means that the playing field is now a different one when it comes to IMF funding. Finally, and in case you think that Latvia has not already cut spending just look at the following estimates for cuts in the public sector:

Taking into account that the budget amendments envisage steep spending cuts, the amendments must be passed immediately, so that the ministries and other government agencies know how much money they will be allotted from the budget this year, stressed the Finance Ministry.

It is planned that the Defense Ministry's budget will be reduced LVL 30.8 million, the budget of the Finance Ministry will be cut LVL 14 million, Interior Ministry - LVL 10.4 million, Education and Science Ministry - LVL 22.1 million, Agriculture Ministry - LVL 20.5 million, Transport Ministry - LVL 109.5 million, Welfare Ministry - LVL 7.2 million, Justice Ministry - LVL 7.4 million, Culture Ministry - LVL 15.9 million, Health Ministry - LVL 39.3 million, and Regional Development and Local Governments Ministry - LVL 10.8 million.

The initial demands would of course represent even deeper cuts and this is the main point in this case; just how much pain can you inflict under a fixed exchange rate before the dam breaks? As it appears, everyone has a breaking point and with e.g. property prices slumping 50% y-o-y in Q1 alone it is not difficult to see the boom-bust nature of Latvia's recent economic performance.

Another and very important part of the picture comes from the fact that it is not only the IMF who is footing the bill in Latvia. Consequently and this is the case for all three Baltic economies the expansion has effectively been characterised by the outsourcing of the financial sector to particularly Nordic banks' subsidiaries and most notably Swedish owned banks. This creates a large dilemma in the context of devaluation since most of the of the credit to corporates and households have been provided in Euros as result of the so-called road map towards Euro entry which was perceived as a fait accomplit. Recently, RGE analyst Mary Stokes explicitly tackles this question in the context of the entire CEE edifice. Mary frames the issue neatly when she says:

The general idea is that these parent banks (as well as the CEE economies in which they operate) are likely to be collectively better off if they all continue to support their Eastern European subsidiaries. The problem, however, is they may not be individually incentivized to do so.

Mary is initially positive in the sense that we won't see a large scale withdrawal of foreign banks from Eastern Europe citing recent evidence in the context of Romania, Hungary and Serbia where foreign banks have pledged to support their subsidiaries despite strong economic head-winds. However, she also makes a very important point when she coins the notion of the asymmetric prisoner's dilemma. What lies behind this term is the idea that because different foreign banks are exposed to a different degree in different parts of Eastern Europe with different economic fundamentals the idea of a common commitment across the board may be difficult. One key ingredient here is of course, as Mary notes via Fitch ratings, that the extent to which banks are exposed relative to their parent companies differ substantially. This is simply to say that while some banks are indeed able to shoulder the inevitable losses which will come in a CEE context, some are threatened on their life [1]. Finally, there is the risk that if one bank decide to give up its support for the subsidiary and thus the domestic economic edifice in its current form, so will other banks do the same. On a macroeconomic level this would of course be tantamount to one economy deciding to devalue which would immediately, one would assume, force others to follow suit.

As you can probably tell by now I am getting closer to the topic at hand. Consequently, I believe that what is now materialising with Latvia as the main venue is exactly this asymmetric prisoner's dilemma that Mary is talking about.

Let us begin first with the simple and ominous sign that lending conditions in the Latvian interbank market have become increasingly tight recently. I already pointed to this in my previous post (see link above) where I noted how the Latvian central bank, through its currency board, has already spent over 500 million euros buying lats. Last week in particular was tough as Bloomberg reports how the central bank had to buy 95.4 million lati ($190.6 million) in order to protect the Lati from moving below its trading limit where it is only allowed to move 1% either way against the Euro (from a mid point). According to Bloomberg, such purchases have already caused the foreign exchange reserve to shrink by 38% between September 08 and april 09 alone.

Latvia’s overnight lending rate rose to a record today because of a shortage of lati on the market after central bank purchases of the currency and Treasury bill sales, said Andris Larins, an analyst at Nordea AB. Asking rates on the overnight Rigibor, the interbank lending market, rose to 14.2 percent after the central bank bought 95.4 million lati ($191.5 million) to support the currency last week. Treasury bill sales and higher interest rates on money the central bank charges to borrow also contributed, Larins said.

As can be seen the effect from these operations are very as they have driven the interbank rate to its highest in more than 10 years as the central bank purchases are sucking up liquidity from the market. The main message here is that the shorter term rates are converging to the annual rate (click image for better viewing).

Especially, it is important to pay attention to the fact that the overnight rate has skyrocketed and even surpassed the annual rate. The overnight rate has risen 1352 basis points since the 21st of May and it indicates verly clearly how much stress and uncertainty which is building up in the market. Essentially this is the effect Bear Stearns/Lehmann had on the Libor back in the days where global interbank markets were freezing over. Moreover, I have from reliable sources that some banks are quoting overnight rates as high as 20% which suggests that things are moving fast at the moment.

But why all this fuss now then?

Well, it is worth remembering that it already began last week and as I pointed out above the larger than expected announced budget deficit cast serious doubt over the potential for future IMF funding. However, a more prominent reason is certainly that the Swedish banks and Swedish discourse in general have begun to turn strongly towards devaluation in Latvia as a sure thing. Last week, the Riksbank strengthened its foreign currency reserve with 100 million SEK, but more importantly SEB Chief Executive Annika Falkengren noted how the level of defaults would essentially be the same regardless of whether Latvia devalued or corrected through internal price deflation. This kind of message from a Swedish bank executive is not without importance since it is, for a large part, Sweden that have financed the Baltic expansion through the heavy exposure of many Swedish banks in the Baltic economies. Up until now however, popular belief has held that since most of the loans having been offered by foreign banks were in Euros these banks would strongly reject devaluation as it would effective eat up a large part of their balance sheet in one sweep. However, as many of us have pointed out these defaults would come anyway as a result of the sharp and essentially brutal deflationary correction. It is exactly this recognition which seems to have trickled down to Swedish bank officials.

As a consequence of this and, arguably, a host of other things Bengt Dennis, a former Swedish central bank governor and an adviser to the Latvian government was quoted this weekend of saying that a Latvian devaluation is a done deal. The only question would be when and how.

Bengt Dennis, the former Swedish central bank governor and an adviser to the Latvian government on how to cope with the economic crisis, said the Baltic country will need to devalue its currency. “No one knows if there will be a devaluation tomorrow or in a few months -- the timeframe is always uncertain -- but we have moved beyond the question of whether there will be a devaluation and should instead focus on how it will be carried out,” Dennis told Swedish state television SVT last night.

This is of course pretty uequivocal and indicates quite strongly how the end game is near. In essence, it is very obvious I think that the sentiment in Sweden has turned from one in which the desire to wait out the storm and take the losses gradually to one where there is a demand for closure and immediate quantification of the losses. This is significant since the longer markets believe that Swedish banks no longer explicity support the peg, the closer we move towards a devaluation.

Clear signs of such sentiment comes from the publication of the Riksbank's Financial Stability Report out today where it is estimated how Swedish banks will lose as much as SEK 170 billion during 2009 and 2010 on loan losses. Now, it is impossible to say whether these estimates implicitly include a Latvian devaluation or not, but one thing is certain; the estimates have the Baltics written all over them and, if anything, the downside looms as a direct function of the potentially worsening situation in the Baltics. Add to this that the Swedish economy in general have endured an absolutely horrendous 6 months across Q4-08 and Q1-09 and it is not difficult to see from where the impetus to pull the plug in the Baltics could come from. Recent figures for GDP indicate how national output fell 6.5% over the year in Q1-09 which compares to an annual drop of 4.9% in Q4-08.

To add to the pressure it also appears that the political tensions in Latvia is growing.

In the first instance there is of course the expected and almost obligatory refutation of the Dennis' comments about the almost certainty of a devaluation.

I hereby announce that an opinion by Bengt Dennis, member of the High Level Advisors Working Group to the Government of Latvia, which he expressed today to the Bloomberg news agency about an inevitable devaluation of the Latvian national currency – lats – is not true, and should be evaluated as expert’s personal, individual opinion which has nothing to do with issues concerned in the first sitting of the High Level Working Group, as well as with the position of the Government of Latvia on overcoming the economic crisis.

This is of course all well and good, but the question is whether we can take this for granted as the "official" position. For starters, Bloomberg (linked above) quotes Justice minister Mareks Seglins for calling a debate about the potential gains and losses relative to a currency devaluation. This would indeed be something new in a Latvian context as a debate about the Lati's Euro peg hitherto has been stifled completely by the official backing of the Lati's value against the Euro. As people closer to the Baltic situation than me have pointed out, this may a specific attempt to stir up things by Seglins since his party are bound to lose local elections come Saturday and may thus lose the majority in parliament.

A Done Deal Then?

Not quite, but it is impossible not to notice that some significant cracks have emerged. I think it is particularly important that Swedish stakeholders in the Baltic debacle now seem to favor "throwing in the towel" through a devaluation as it is assumed that it would amount to same thing, in the end, as trying to keep things together. Of course, no one other than Latvia herself can choose to devalue but the signs from Sweden are very important in the sense that the Swedish banks are paramount in keeping the economic edifice together. Moreover, there is the IMF where we do not yet know whether bailout funding will continue with the new estimate of 2009 budget deficit. My guess is that the IMF won't stand for it but then again, it would be wise to cut some slack if they have an interest in keeping the peg (which I am not it really wants).

I will end as I did last time with a general warning. At this point rumours will drive the discourse as much as real economic fundamentals and political decions. However, it is difficult to deny that a devaluation in Latvia seems to be moving closer.


[1] - Incidentally and for all the complaints about me focusing too much on the similarities between the CEE here is an example of differences. This is to say that when it comes to a high degree of event risk there are of course notable assymmetries. What I would like however to point out is that when it comes to the fundamentals and the underlying problems/courses of the crisis the Eastern European countries are, in many cases, strikingly similar.


Kristjan said...

is the 7% really the initial allowed budget deficit (for the IMF deal)? I thought it was 5%.

Could you be so kind and make a list of all the loans that Latvia has requested during this crisis? I'd like to see the numbers and the lenders.

Thank you

CV said...

Hi Kristjan,

Claus Vistesen here (the author :)) ... you are right. This is my blunder. 5% is indeed the original IMF limit whereas 7% was the "suggestion" the government presented as a compromise before this new report about a 9.2% deficit.


"could you be so kind and make a list of all the loans that Latvia has requested during this crisis? I'd like to see the numbers and the lenders."

Uff, well ... let us see whether we will get time for this one. But you are right. It would be interesting to take stock.


Edward Hugh said...

Hi Kristjan,

"is the 7% really the initial allowed budget deficit (for the IMF deal)? I thought it was 5%."

Thanks for pointing this out, itis obviously a typo on Claus's part.The original agreement was for 5%. The government are now trying to negotiate 7% (which is probably doable, if....) but the actual budget before parliament has a deficit of 9.2% on current contraction assumptions.

"Could you be so kind and make a list of all the loans that Latvia has requested during this crisis?"

Well, as far as I can remember (help me someone if I have forgotten something) Latvia only really has one loan - 7.5 billion euros from a group led by the International Monetary Fund and the European Commission: According Anders Alsund this is the “biggest bailout package in world history”, proportionately that is, since it is equivalent to about 34 percent of the (then) gross domestic product, and now probably amounts to a lot larger proportion, although as in the case of Hungary, not all the loan is actually for "spending" purposes, although even on November 2008 IMF calculations, following the Parex restructuring etc gross debt to GDP was going to go to some 55% of GDP in 2010, and now with real GDP shrinking, and deflation leading nominal (current price) GDP shrinking even faster they are sure to be over the 60% limit of debt to GDP by 2011, which means they have no euro exit strategy in any event. Which doesn't leave them too many options.

As for the original loan, the IMF provided 1.7 billion euros, the Nordic countries 1.8 billion euros and the European Union 3.1 billion euros. The balance was covered by the European Bank for Reconstruction and Development (EBRD), the World Bank, Poland, Estonia and the Czech Republic.

The has also been more recent talk of a 150 million euro loan from the EBRD to encourage bank lending.

Edward Hugh said...

LONDON, June 3 (Reuters) - Latvia's Treasury failed on Wednesday to sell any of the 50 million lats $100.7 million) of various Treasury bills offered for sale. The failure to attract offers for the paper is exacerbating fears for the lat currency which many analysts fear is headed for a devaluation.

GYULA TOTH, EMERGING EUROPE ECONOMIST AT UNICREDIT IN VIENNA "Latvia has failed to sell any of the four series of debt offered at today's auction and increases further focus on devaluation risk, following recent high level devaluation comments and FX reserves losses. The auction failure follows a significant further increase in Overnight money market rates, against the backdrop of Bank of Latvia reserves losses. Against the backdrop of a potentially near double digit fiscal deficit in 2009 clearly this failure goes to the heart of Latvia's vulnerabilities and starts to more meaningfully diminish the govt's ability to hold out." AGATA URBANSKA "If the IMF tranche does not come in soon then the story changes for Latvia, leaving them in a much worse position in terms of defending the peg."

BEAT SIEGENTHALER, CHIEF STRATEGIST, EMERGING MARKETS: "Market pressures are building on Latvia. The central bank has been selling euros to support the lat and its reserves are shrinking. Their intervention has pushed up interest rates. Nobody wants to hold the lat for a prolonged period of time and liquidity has dried up. This is an unstable situation. There has to be some outside help either in the form of the ECB or IMF or there will be a devaluation. Another alternative is to introduce capital controls."

Kristjan said...

"As for the original loan, the IMF provided 1.7 billion euros, the Nordic countries 1.8 billion euros and the European Union 3.1 billion euros. The balance was covered by the European Bank for Reconstruction and Development (EBRD), the World Bank, Poland, Estonia and the Czech Republic."

Thank You!
That's exactly what I wanted to know. I tried searching Bloomberg for it but there was so much noise and none of the articles provided a concise overview.

Mary said...


I basically agree with everything you wrote. I would go so far as to say (which is pretty much what you seemed to be saying) and that is, that the game is up and a devaluation looks inevitable. It's just a question of when and how much of a ripple effect it will have. As you pointed out, the fact that anyone even connected with a Swedish bank is discussing the idea of devaluation openly means that they're looking to get it over and done with.

I do, however, stick with the argument I made in December and again recently in May (see link below). Whether Latvia devalues or doesn't devalue (and it looks like it will certainly devalue), I'm concerned about the contagion effects.

Contrary to what many commentators might soon claim, I think that while postponing devaluation was certainly painful, hopefully it bought officials time to come up with contingency plans to prevent a domino effect beyond the Baltics. For example, I see the fact that Poland recently reached a deal with the IMF for a flexible credit line as a very positive sign, which will further insulate that economy from potential contagion.

With a Latvia devaluation, I'm pretty convinced that Estonia and Lithuania will follow behind. However, the big question in my mind is how such a devaluation will affect the rest of the CEE. I found it interesting that Bloomberg was attributing a weakening in Central Europe currencies yesterday to mere talk of a Latvian devaluation. In my mind, that doesn't bode well for a CEE decoupling from problems in the Baltics.

I'd be interested in your takes on whether you see a CEE 'decoupling' from Latvia and if not, how badly/immediately you think the rest of the region could get hit.

See my Latvia: Will It Start A Dangerous Domino Effect?

All the best!

Edward Hugh said...

Hi Mary,

"I'm concerned about the contagion effects."

Me too. Basically the pressure will hit the rest of the Baltics first and then Bulgaria. But Hungary will definitely take a hit from the shock.

Portfolio Hungary this afternoon:

"Hungary's forint has started to ease against the euro in tandem with its regional peers at around 14:00 CET on Wednesday, as regional risks have increased and global investor sentiment has worsened. The HUF eased to 288 to the EUR, the weakest level in a week, while it was as strong as 279 in the morning session. Poland's zloty and the Czech koruna are also under pressure, but the depreciation of the forint (cc. 3% intraday) is by far the biggest."

Edward Hugh said...


This was one from before I went away from the weekend.

"BTW Estonian government is rising excise duties again because there are some pan-European regulations about minimum levels we must reach and this have also added some to Estonian inflation over years. All other things equal this would show (via REER) that Estonia is losing competitivness. So you think it's a good idea to devalue to get price of the gasoline lower or what?"

The thing is this, Europe is not self sufficient in energy, and we consume far too much. So there is a policy of trying to discourage use via taxes, and these need to be harmonised to make sense.

The big picture situation is that food and energy are going to become more expensive, since previously one billion people have been living well, and five billion living badly, while now we will move to three billion people living well, and four billion living badly (between now and 2020, population is growing globally, up to nine billion by 2050).

This is basically good news, since collectively (as a species) we will be better off, but obviously the one billion, who are largely in Europe, Japan and the US, will need to adjust downwards slightly, since energy costs will go through the roof otherwise at some point.

This is what all this is about, and not REERs. Except, of course, that with everyone working on the samebenchmark tarrif, then the only differences should be in energy efficiency - ie productivity, and that is what it is all about at the end of the day anyway.

Edward Hugh said...

Here's another one from before the weekend:

"At least in Estonia big part of cuts are already done. I saw some gallup recently, where 2/3 of questioned said that their salary have been reduced already. 10%...50%, whatever. For more bonus oriented posts decline have been even >75%."

The thing is I want to STRESS, this is not about reducing living standards, it is about improving international competitiveness, so basically wages and prices need to come down IN TANDEM.

There is no evidence for anything like such reductions in prices in the price index yet.

Internal devaluation or external is more or less the same here. The only difference is the length of time the correction takes.

The drop in living standards is produced by the recession, not the wage and price correction. It is the recession that produces growing bankruptcies, rising unemployment, less overtime etc.

This is why, eg Poland, is able to only flirt with recession due to the ability to devalue, and then use exports to take some of the strain from weaker internal demand, but then they were applying a monetary policy to avoid all that inflation in the first place, and forex lending was nothing like as extensive.

Estonia can emulate Poland by doing the same sort of internal devaluation, but we need to see price indexes dropping rapidly, and time is passing.

Poland has devalued around 20% to the euro, and had much less inflation than the Baltics. I doubt that there price level was really that much higher in 2000.

I am waiting really for Eurostat to publish the 2008 REER numbers, then I think a direct comparison with Poland will be instructive.

I mean, basically my view is that you are trying to do something that is almost "super human", but I respect that this is your decision, and I am certainly not going to do anything to put obstacles in your path. I am simply here to bear witness to what you do. If I am wrong, and you can do it, then good luck to you all, of course.

Same thing with the euro really. I always anticipated the sort of problems we are now seeing in Ireland and Spain if you apply a thoroughly inappropriate monetary policy for several years. But once the decision was taken to have the euro I ahve more or less accepted it. Try to make the best of a bad situation, etc. This is what I call pragmatism.

Hence my campaign for having a fiscal dimension and a federal europe, since I think it is the only way the thing can work. Spain needs a huge injection of money via the EU bonds, but I see this morning that Angela Merkel is throwing things into reverse gear:

“Even the European Central Bank has somewhat bowed to international
pressure with its purchase of covered bonds.”

(See article in the Financial Times).

How much of this is electioneering is hard to say, but Spain needs the ECB to buy the covered bonds (cedulas hipotecarias) and loads of them (circa 300 billion euros) or the banks will simply go pop.

Well, OK, that was a long digression, but the simple point I am trying to make is that all this is very complex, although I suspect that many people in the Baltics are now getting a crash course in economics.

Kristjan said...

I'm sure Edward and Claus have already read these three pieces, but just for discussion's sake, I'll throw them out here:
Latvia Fails in Treasury Bill Auction, Gets No Bids
Latvia’s Chance of Devaluing Lat Seen at 30% in 3 Months by ING I really don't know how they got these numbers, I'd sure like to see the report. The numbers seem and feel kinda right, but still, no pic no proof!
Latvian Property Market Was World’s Worst in First Quarter

Jack Weslhery said...

EUROSTAT shows 1,9 % of GDP INCREASE in 1Q 2009 in Poland so Polish Zloty should be stronger than just now. Polish market is in good condition.

I suppose Baltic countries also are not in bad condition, but the strongest in EU is just now Poland.

Edward Hugh said...

"EUROSTAT shows 1,9 % of GDP INCREASE in 1Q in Poland so Polish Zloty should be stronger than just now. Polish market is in good condition."

Well I wouldn't go so far as to say good condition, but it is doing less badly than the rest. That is obvious. But maybe it is doing less badly precisely because the Zloty is weaker.

Edward Hugh said...

Hello again Kristjan (V)

This is getting more surreal by the day. I thought there were differences in tone, but just put that down to something in the local water, now I know differently :).

But coming to the serious point, if you are interested in Edward Lucas, you may also be interested in his reply to my Bad Journalism At The Economist Afoe post (July 2007) on their Certain Ideas Of Europe blog. I think that should put Edward Lucas in perspective for you. He is a micro, not a macro, economist and thus understands little of the core issues, he patently saw non of this coming, and thinks that institutional changes like longer shopping hours are what produce economic growth.

Basically some of these people (who saw neither the general demographic problem driving the inflation, nor the inevitability of the hard landing, nor the fact that internal devaluation would prove to be so difficult) will have the riot act well and truly read to them at some point, but this is not the moment for post-mortems, since we have far more pressing problems on our hands.

You may also be interested in my general replies at the foot of that post, which are directed not so much at him, but at the Economist collective. It is a kind of Martin Luther nailing your manifesto to the door kind of thing. Purely for posterity. It already looks good. They were talking about Goldilocks recoveries in Japan and Germany (and just look at them now), and their India correspondent, with his moveable feast overheating GDP growth rates, is a complete bufoon, as I hope I demonstrate.

Basically, you could say I was a "one man editorial board in exile" - like the legendary King Arthur I await the call from my country to return, and put some sort of order in what has effectively become a "man for all seasons kind" of dishrag.

I can remember the days when I used to rush to the library magazine shelf every Friday desperate to get my hands on the latest issue. Talk about decadence!

Edward Hugh said...


"BTW I recommend to compare the size of the Latvian economy with CEE and Eurozone to get some idea about spillover efects."

Size doesn't matter here. Take a crow bar, and start to waggle it to open a strong box. The most difficult bit is to get the thing inside, and then to prize open the first millimetre. The hard bit is that first millimetre, after that its all downhill work.

Latvia is simply the first millimetre. You will see.

Edward Hugh said...

Well, I'm glad that we've all been properly introduced now :)

Edward Hugh said...

Hello Krisjan (whichever),

"Edward, so how much "money is spent" so far?"

This isn't the problem. This is a solvency, not a liquidity problem. There is no doubt in my mind they need serious debt restructuring. The population dynamics going into the future cannot support the kind of liabilities they are accumulating, and that is that. And the EU needs to face up to this at some point, and, of course, it isn't only Latvia.

The short term problem is one of Lat liquidity. The IMF can pump more money in. This is a decision which they have to take. But the question is, before doing the debt restructuring and the price correction, what is the point in simply slashing the fiscal deficit? This just sends the economy down and down the plughole - which was what those who argued for dealuation from the start always understood.

"BigMac index is "scientific fact" showing kroon more than 40% undervalued."

Look. The only "scientific fact" that matters here, as I have stressed repeatedly is how much the price level has to adjust to generate sufficient trade surplus in goods and services to both cover the current account income deficit AND generate headline economic growth. The only way Estonia can get back to headline GDP growth is via this trade surplus since domestic demand won't do it, and the government is cutting spending.

With devaluation you can get this correction in a matter of weeks, without it how many years will you need? This is what we will now put to the test. The real exchange rate will be that which gives the necessary trade surplus, and that is that. You may not like Newton's theory of gravity (which isn't quite right in any event, like the REER) but that doesn't mean that apples fall upwards from trees.

All the rest is simply pointless shouting and noise.

Edward Hugh said...

I know some people don't like them, but here (below) is the Danske Bank Emerging Markets briefing for today.

They rightly draw attention to the silence from both the IMF and Sweden. There is obviously a lot of discussion going on behind closed doors at the moment.

Danske are also absolutely right to focus on contagion. The whole issue now coincides with growing concern at the level of global equities that the recovery in 2010 may not be as straightforward as it seemed at month or so ago. Bernanke has urged a reduction in the US fiscal deficit, which means little GDP growth (if any) can be expected in the US next year. This is very bad news for Germany and Japan, and (indirectly) Russia.

Russian stocks reacted sharply yesterday, while Czech Prime Minister Jan Fischer said it may be “ very difficult” for the economy to return to growth next year as projected by the Finance Ministry and the central bank.

So hold on tight everyone, coz here we go.


Baltic worries have clearly moved to the top of the agenda in EMEA markets with devaluation fears escalating rapidly during the past week. Concerns regarding a devaluation of the Latvian lat increased further yesterday after Latvian Prime Minister Dombrovskis in comments to local media ruled out a devaluation of the lat while going on to say that if a devaluation were to occur it would be of the order of 30% rather than 10-15%. Devaluation concerns rose again when a government bond auction attracted no bids.
In an interview with CNBC Mr. Dombroskis said yesterday night that Latvia needed to reach an agreement with the IMF and EU quickly and that “fears of a domino effect in [the] region to a certain extent [are] justified”. Mr. Dombroskis also said he expected an announcement on progress with the IMF at the beginning or middle of next week.

With little macroeconomic data scheduled for release in the region today, markets are likely to continue to focus on the Latvian situation. We would focus especially on any hints by the country’s officials regarding a possible devaluation, and on news from Stockholm concerning whether the Swedish government and central bank comment on the situation in Latvia. Further, any news from the IMF, currently visiting in Riga, is likely to be very important for CEE markets. We think it worrying that neither the Swedish government nor the IMF have made any serious attempts to allay market concerns regarding a possible devaluation in Latvia.
 Today is an historic anniversary in Poland marking the 20th anniversary of the country’s first free elections. (See our overview of the past 20 years in Poland including its freedom and economic transition here).

Increasing concerns regarding a possible devaluation in Latvia yesterday spilled over into other countries in CEE. Although the direct link between the Baltic markets and others such as Poland, Hungary and Romania is very limited it is only natural that concerns over the situation in Baltic States triggers renewed concerns regarding the position in Central and Eastern Europe where many countries to a greater or lesser extent face problems similar to those in the Baltics. Those most at risk from negative spill-over effects are Latvia’s neighbours Estonia and Lithuania although we would expect contagion to affect countries in the region most like Latvia in terms of macroeconomic imbalances such as Romania and Bulgaria.

Given significantly increased event risk in the CEE we generally recommend exercising considerable caution in all CEE markets and would expect both negative and positive news from Latvia to drive all CEE fixed income and FX markets in the coming days. In other words, don’t be surprised if further bad news from Latvia weakens the forint, leu and zloty yet further.

Anonymous said...

On the prospects for contagion in Bloomberg:

Buy Hungary 5-Year CDS to Hedge Possible Latvia Crisis, UBS Says
Share | Email | Print | A A A

By Stephen Kirkland

June 4 (Bloomberg) -- Investors who seek protection against a possible crisis in Latvia may buy correlated assets as a proxy given liquidity constraints in the country’s securities, UBS AG wrote in a note to clients.

Hungary’s credit-default swaps have shown high correlation and “we maintain our recommendation to buy five-year CDS in Hungary,” the brokerage wrote.

Last Updated: June 4, 2009 02:24 EDT

DD said...

On the prospects for contagion in Bloomberg:

Buy Hungary 5-Year CDS to Hedge Possible Latvia Crisis, UBS Says
Share | Email | Print | A A A

By Stephen Kirkland

June 4 (Bloomberg) -- Investors who seek protection against a possible crisis in Latvia may buy correlated assets as a proxy given liquidity constraints in the country’s securities, UBS AG wrote in a note to clients.

Hungary’s credit-default swaps have shown high correlation and “we maintain our recommendation to buy five-year CDS in Hungary,” the brokerage wrote.

Last Updated: June 4, 2009 02:24 EDT

DD said...

On the prospects for contagion in Bloomberg:

Buy Hungary 5-Year CDS to Hedge Possible Latvia Crisis, UBS Says
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By Stephen Kirkland

June 4 (Bloomberg) -- Investors who seek protection against a possible crisis in Latvia may buy correlated assets as a proxy given liquidity constraints in the country’s securities, UBS AG wrote in a note to clients.

Hungary’s credit-default swaps have shown high correlation and “we maintain our recommendation to buy five-year CDS in Hungary,” the brokerage wrote.

Last Updated: June 4, 2009 02:24 EDT

Kristjan Velbri said...

Latvia denies currency pressure
At the same time, RIGIBOR has reached 16.8%!

Tallinn Resident said...

I wonder what the least worst currency is, then, to keep for the time being...
Euros, or dollars...
Or something else?...